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To help deal with the financial pressures brought on by the pandemic in 2020, many companies across sectors have cut their dividends – choosing instead to hold more profits as cash reserves to weather harsher global economic conditions. This, of course, has had a big impact on income investors – i.e. those who draw a significant monthly income from dividends and/or other income generating assets (e.g. bonds). In this article, we explore what impact this has already created on income investors and what the outlook might be as we enter 2021.
Interest rates & dividends
In March 2020, central banks in many developed countries – such as the Bank of England (BoE) and US Federal Reserve – slashed interest rates to try and protect national economies from the worst effects of the pandemic. As a result, returns on savings took a large hit – but at least many investors could rest assured that their dividend-paying investments were still generating a good income. Sadly, it did not take long for the resulting recession to catch up with dividend stocks.
A large number of companies – both globally in the UK – reduced or stopped their dividends in 2020 in response to the harsher economic climate. By May, for instance, cuts and deferrals to dividends topped £30bn including prominent names such as HSBC and BT. By August 2020, moreover, 445 of the UK’s biggest firms (listed on the London Stock Exchange) had slashed, suspended or stopped their dividend – including half of the FTSE 100.
The road ahead
2020 has highlighted an uncomfortable lesson from history – i.e. recessions destroy dividends. When the “Dot Com Bubble” burst in 2000, for example, UK dividend income fell by nearly 18% – with US and European dividends also affected. During the 2008-9 Financial Crisis, moreover, the average fall in UK dividend payout was even worse – i.e. a decline of almost 30%.
Fortunately, the good news from these events is that, in the end, dividend investors tend to muddle through. Moreover, there are reasons to believe that the 2020 pandemic-induced recession may not hurt dividends as much as previous ones. Some businesses, for instance, have actually kept or even raised their dividends as 2020 has progressed. Examples include M&G Plc (financials: 10% yield), BP (oil & gas: 6.6%) and Imperial Brands (tobacco: 10.26%).
For those determined to continue dividend investing, therefore, COVID-19 has not made this an impossible task. Yet the pandemic has certainly made it more challenging. Such investors will likely need to be far more picky about the stocks they choose for the portfolio. For most ordinary investors looking to grow their wealth and diversify appropriately, this will likely not be the right approach for your portfolio and investing on a ‘total-return’ basis remains the likely best way. ‘Total-return’ means the combined gain from both capital growth as well as dividend income.
Even those investors with a proclivity to dividends should be wary of stocks with very high yield (e.g. over 8%) in the present environment. This may be a market sign that the stock is unstable. One risk-mitigation strategy to consider in light of COVID-19 is to think about exchange-traded funds (ETFs) focusing on dividend-paying securities across industries. This is likely to reduce the overall impact on your portfolio if there is a significant price change in any single stock.
If there’s one thing that events in 2020 have shown investors of all kinds, it’s that portfolios must have a strong diversification strategy and long-term investment horizon to help weather storms. Whilst there are reasons to be somewhat optimistic about markets and economic recovery in 2021 – especially in light of recent vaccine announcements – the situation remains volatile and it will be important for investors to keep a steady head, turning to financial advice when needed.
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